Would Stamp Duty reform make a difference?

The Scottish Government now has the power to reform Stamp Duty Land Tax – the tax buyers pay on purchases of residential property. But should it?

The current Stamp Duty charges.

Stamp Duty has been widely criticised because of its ‘slab’ nature. If you buy a property for just a pound over one of the thresholds for the tax, you pay the higher rate on the full amount of the purchase price.

Advocates of reform argue that the tax should be changed so that the higher rates of tax are only paid on that part of the purchase price above the relevant threshold. That way you eliminate distortions to the market as people try to keep below a particular tax threshold.

Sounds sensible enough, but could it work in practice? It’s more difficult than you might think.

Take someone buying a property for £339,000. Today they would pay £10,170 in Stamp Duty (i.e. 3% of the total purchase price). Now imagine a system along the lines proposed by the reformers where only that part of the purchase price above a threshold is taxed at the rate for that threshold. Assume that the starting threshold for paying tax (£125,000) remains the same to avoid penalising first time buyers.

To raise the same amount of tax for our sample purchase, the government would have to introduce tax thresholds looking something like this:

To make sure that the same amount of tax is raised from this transaction, the government would probably have to increase the number of thresholds and sharply increase the amount of tax paid at each threshold.

Now apply these tax bands to a more expensive property, say one selling for £499,000. Assume that the tax above £300,000 remains constant at 7.5%. The total tax on this property under the new system would be £17,300. That is £2,330 more than would be currently paid (3% of £499,000 = £14,970).

To make sure a graduated tax raises the same amount as the current system, the tax rates would have to be a lot higher above the starting point of £125,000. And that would have the effect of sharply increasing the tax paid on more expensive properties.

You might, of course, think that a more progressive tax would be a good idea, although plenty of homeowners who expect to see capital growth in the next 10 – 20 years might not agree with you. But there is very little room for maneouver. The Registers of Scotland reports that the average selling price in Scotland is roughly £149,000. The average selling price of a detached house – the most expensive type of property – is £220,000. In other words, an increase in tax from the most expensive properties is not going to contribute much.

In theory, the tax rates could be calculated in a way that reflects the make up of the Scottish market to raise the same amount of income. But it would be a complicated calculation. And most of us would still end up paying pretty much the same amount of tax as we do now.

Is that an improvement? Possibly. It could be a little more progressive and there are no sudden jumps in tax that provide an incentive to manipulate the selling price. But I suspect that the reformers really want to see an overall reduction in the tax rather than just a change in the way it is applied. And in current circumstances, that seems unlikely.